Fed Stresses Over Foreign Banks

WASHINGTON — The Federal Reserve began flexing its muscle as the de facto global financial regulator on Wednesday, rejecting the capital plans for the U.S. units of three foreign banks.

The Fed, which for the first time subjected three foreign banks to its annual “stress test” process, identified problems in their ability to calculate how they would withstand a severe economic slump. The Fed barred the U.S. units of London-based HSBC Plc., Spain’s Banco Santander SA and Royal Bank of Scotland Group Plc., from paying increased dividends to their parent firms and said they’d have to resubmit their capital plans. The units can continue to pay dividends based on last year’s levels.

The move is the latest indication the regulator is taking seriously its effort to shore up large banks whose collapse could ripple through the global financial system. The Fed said all three foreign-based banks had problems that “call into question the overall reliability of their capital planning process.”

The capital plans of two U.S.-based banks were also rejected, including Citigroup Inc. and Zions Bancorp. Another 25 banks were given the green light to begin rewarding shareholders

The delay in paying increased dividends to the foreign parent “will capture the attention of the boards of those banks,” said Thomas Day, senior director at Moody’s Analytics. Mr. Day said the banks would have to give more specific, detailed financial data to the Fed in the future.

“The Fed requires us to improve our process, and we will do so,” said Gerard Mattia, chief financial officer of HSBC’s North American unit.

“We clearly have more work to do to meet the Fed’s standards, and we’re fully committed to doing that,” said Bruce Van Saun, chief executive of RBS Citizens Financial Group, the U.S. unit of RBS.

All three banks were rejected even though their projected capital cushions in a time of severe economic stress were above Fed’ mandated levels. Instead, the rejection was based on what the Fed called “qualitative concerns,” mainly due to problems estimating revenue and losses for their operations during a period of turmoil.

The Fed’s move is likely to likely to inflame tensions with European regulators, who have criticized the Fed’s move to regulate foreign banks as encroaching on other their turf.

At RBS and HSBC, the Fed identified deficiencies in their practices for estimating revenue and losses during periods of stress.

And at Santander, the Fed found “widespread and significant deficiencies in several areas, including governance, internal controls, risk-identification and risk management.”

In a statement, Santander said it would resubmit its capital plan to the Fed and said the calculations in the stress tests did not incorporate $1.75 billion in cash transferred from its parent company in late February.

Earlier this year, the Fed passed new rules subjecting even more foreign lenders to U.S. rules on capital, debt levels and the stress tests.

Under the rule, foreign bank organizations in the U.S. with at least $50 billion in non-branch assets in the U.S. would have to form an intermediate holding company to act as an umbrella over their U.S. subsidiaries. It would expand the Fed’s stress-test process to lenders such as Deutsche Bank AG, Credit Suisse Group AG and Barclays PLC.
The Fed’s annual “stress” tests are designed to ensure large banks can handle a deep slump like the 2008 financial crisis and continue lending without needing a government rescue.

As part of Wednesday’s results, the Fed makes a decision on each company’s planned dividend and stock buyback plans over nine quarters, and takes into account their capital buffer after a severe economic shock.